Alessandro Rebucci: Higher oil prices have contributed to exacerbating an already large global imbalance, both directly and indirectly, thereby increasing the risk of a disorderly resolution of these imbalances. They have directly contributed to a further worsening of the U.S. current account deficit by about two percentage points of GDP accounting for about half the deterioration over the past couple of years. Indirectly, they also contributed by redistributing surpluses from China and other emerging Asian countries to oil-exporting countries, which tend to import relatively less from the United States; therefore, inducing a second order effect. Having said this, it's important to keep in mind that while higher oil prices are a contributing factor, they are not the ultimate source of these imbalances which started much earlier than increasing oil prices, which initially moved in 1999 and were more sharp in 2003.

Question: How does today's world compare to the 1970s when the global economy was buffeted by a major oil price shocks?

Alessandro Rebucci: Well, the magnitude of the shocks that we are witnessing today is comparable to those realized in the '70s, the environment in which these shocks have taken place is quite different. There are at least three important differences, compared to those earlier episodes.

First of all, monetary policies are more credible around the world. This suggests that for any given shock, the authorities can respond less aggressively than in the past, and thereby triggering lesser adjustment in the real economies to this kind of shock.

Secondly, today's world is much more financially integrated than in the past. This means that unlike in the past, asset prices can also contribute or exacerbate external adjustment. It does happen that in the specific case of the United States, which is at the core of these global imbalance issues, asset prices help and facilitate adjustments. So this is the second reason why the real economy this time around could adjust less than in the past, in response to what used to be a nasty type of disturbance to the world and individual economies.

Thirdly, oil exporters are wisely spending their increased oil revenues at a slower pace than in the past, mindful of their negative experiences in the '70s. As a result, it is reasonable to expect oil surpluses will persist longer than in the past.

Question: There's a lot of talk about petro-dollar recycling. Do we know where the oil money is going and what effect it's having on international capital markets?

Alessandro Rebucci: The short answer is that we don't know. We do not have a good answer to the question. A slightly longer one is the following. We do have evidence that international capital flows are keeping yields in the U.S. bond market depressed, including in the government bond market, on the agency's bonds, and on the corporate bond market. And international capital flows stemming from increased, revenues are part of this flow, so we have good reason to believe that the recycle of petro-dollars is having an effect on U.S. interest rates by keeping them lower than otherwise. However, it is virtually impossible to prove this scientifically, not least because much of the data needed to perform this kind of analysis are simply not available because they are not published by oil exporting countries. But to summarize, I think the available evidence combined with anecdotal evidence emerging in the press, in the private sector and in this commentary, suggest that oil prices are contributing to global liquidity and worldwide low interest rates.

Question: And finally, is there a role for policies in facilitating adjustment of these oil imbalances?

Alessandro Rebucci: Policy has an important role to play, as the IMF has repeatedly voiced in what is now called the IMF mantra. In the case of the oil imbalances, there are at least two ways in which specific action can improve the situation. Oil exporting countries could safely accelerate the pace at which they're spending their revenues, given that there is a widespread consensus that oil prices will stay at the currently elevated level for quite some time. Their challenge is to spend wisely, take the development opportunity and make the most of it by spending in health, education and the needs of their population. All those countries in which pass through of international energy prices onto domestic energy prices has not been allowed completely, would certainly benefit from accelerating this process, perhaps providing direct budgetary support for the weakest elements of their populations when this is an issue, but thereby accelerate external adjustment to the shock in their own countries, and hence, contributing to a smoother adjustment at the global level.

Question:Over the past year, we've seen a boom in commodity prices, high energy prices, and strong global growth. Yet inflation has stayed low across the globe. Why haven't prices for other goods shot up at all?

Thomas Helbling: Well, this low inflation over the past year or—past one to two years has indeed been remarkable. Now, some people have argued that globalization may have played a role, and their argument is greater international competition forces domestic producers to keep a lid on their prices because their foreign competitors cannot just raise prices. So if you think that this competition has increased and is likely to increase further, these people have then argued that this has sort of kept inflation under control.

Now, it's important to recognize that's one hypothesis, and it's not universally shared. Other people have argued that monetary policy has played a role. Monetary policy is more credible. Policymakers are more vigilant to any sort of uptick in inflation. And other explanations, for example, have also included more general productivity increases, say because of the information technology revolution. So what we do in this chapter, is actually have a closer look at the relationship between globalization and inflation and examine to what extent it's really globalization that has kept the lid on inflation.

Question:In the chapter you put—in the chapter you put great emphasis on the distinction between changes in relative prices, say those of imports relative to domestic prices, and inflation. Why is this distinction so important?

Thomas Helbling: Well, I think, you know, it's important to understand that when we talk about globalization, it affects prices, the price level that you pay for a good, and the channel is very direct, and you can see it. If you have the possibility to import some goods at a much cheaper price, that's what people do. And that is what we mean by relative prices of some goods have decreased. And when we say relative, it's relative to the general price level. Now, what's important to realize is that, say, lower relative prices do not necessarily need to translate into inflation. It depends on a number of factors. For example, one thing that we emphasize in the chapter is that these changes have to be relatively large because you would have a wide consumption basket, so if the price of one good changes, even though it may be a part of the consumption basket, it doesn't have a large effect.

Second, what you also have to realize is, people change patterns. It is not just that if the price of one good decreases, that all other prices will decrease. Some other prices will go up because people get extra income. So they may spend that on other goods. And if you look at it historically, you see that the prices of goods have been decreasing over a long period relative to services. The main reason for that is higher productivity increases in the production of goods. And what you see is people over time have started to spend more money on services. And then, finally, I think—and that's sort of the key distinction—is that globalization or the impact of globalization is on relative prices, and as we show in the chapter, we document the trend in relative prices. But, however, when you talk about inflation, this is the change in the price level per se, and this is what we emphasize in the chapter, that ultimately the change in the absolute price level is very much determined by monetary policy. Now, this brings me to something else. When you look at the relationship between globalization and inflation, there are a number of channels, and the channel we have been talking about right now is the channel of the impact through import prices. There are a number of channels. Particularly important or perhaps frequently mentioned is the relationship between globalization and monetary policy more generally. And some people have argued that globalization forces policies to be more disciplined for a number of reasons. One reason is that in more open economies, monetary policy has less of an effect on output. So monetary policy action ultimately will have less of an effect and monetary policymakers will not be tempted to have more expansion in monetary policy and raise prices to stimulate the economy. And people have argued and have actually shown in some cases that this has been an important reason. In emerging markets, it has also been argued that monetary policy is like an indicator or inflation and monetary policy can be seen as indicators of good policies. So if you have capital inflows or you have foreign investors that are very sensitive to what monetary policymakers do and how inflation behaves and take inflation as a sign of good policies, they will look out for that, and policymakers will actually be forced to pursue low inflation policies, because otherwise that foreign capital will just leave again and put pressure on the balance of payments and on the economy more generally.

Finally, I should also mention that what we look at in the chapter is the inflation process. We look at inflation over the business cycle. And that's perhaps the last important effect that globalization can have. It reduces the sensitivity of inflation to the domestic economic conditions. So there is a disconnect between inflation and domestic economic conditions. Traditionally what is said is, the stronger the economies, the more prices rise, so the higher inflation. What you have in more open economies is a disconnect between your domestic production and prices in general. An important reason for that is that if production increases, you always have the possibility to import. So if you have capacity constraints in the domestic economy, they matter less for prices. And, indeed, we find evidence for that in the chapter.

So, to summarize, we look at the relationship between globalization from a number of channels. One is the direct effect through import prices, where we find, that import prices declines if they're general enough, if they're substantial, and can have an effect on inflation. But this inflation effect is short-lived. Second, to some extent, we have found documented evidence that globalization can change monetary policy objectives. And, finally, globalization has changed the behavior of inflation over the business cycle.

Question:Besides import costs, are there other channels through which globalization affects inflation?

Thomas Helbling: Yes, there are, and we look at at least two channels. One channel is the relationship between inflation and the domestic business cycle. As you know, traditionally the notion is that inflation rises over the cycle, so when activity gets stronger, unemployment declines and so on and so forth. Inflation is increasing because expansion increases. What we then look at is whether globalization has changed this relationship, and the argument is that you have a de-linking between prices and the state of your domestic economy, and the main reason for the de-linking is the possibility of importing. So an important factor in this is, of course, the import share. How much do economies import and export? This share has been increasing and, secondly, it also then depends on the ease at which you can import and export, and in that sense globalization through more capital flows has allowed for larger trade deficits or surpluses over the cycle. So in this sense, this de-linking between prices and inflation, and your domestic economy has become greater. We present evidence in the chapter that this has been indeed a relatively important channel.

Another channel that has long been discussed is the relationship between globalization and policy incentives. Well, what do we mean by policy incentives? What we mean is the incentive to pursue sound macroeconomic policies. Now, when it comes to inflation, what matters most is monetary policy. So if you want, the issue is—has globalization reinforced the incentives for policymakers to pursue policies that guaranteed low and stable inflation? We don't look at this question in much detail in the chapter, the main reason is that in industrial countries, on which the chapter is focused, we think that over the last 10, 15 years, globalization has not played that much of a role because inflation targets were already low or have been low and have not changed much over that period. On the other hand, we have a box in the chapter where we document that the linkage between globalization, if you want, and policy intent has played a greater role for emerging markets. There is indeed some evidence that this channel can be important. In other words, globalization may have some effect on policymakers and induce them to pursue better inflation policies.

Question:Do we still need to worry about inflation with globalization? In other words, has globalization stayed inflation?

Thomas Helbling: No. In fact, that is one of the key points we make in the chapter—you still need to worry about inflation. Now, if you look at one particular channel that we discussed before, namely, the impact of globalization on inflation through import prices, it is true that, import prices have been declining relative to domestic prices, but over a one to two-year period there is sort of downside risk and upside risk or downside and upside potential to the impact on inflation. What you have seen is we have had a very strong global economy, and activity has been strong all over the globe, not to the same extent, but, nevertheless, it has been such a strong global economy that import prices for many goods actually have started to increase. And we think at the moment that there's more upside risk so that from the external side, globalization over the next one to two years may actually contribute to rising inflation rather than decrease it. And then let me just go back. While we have argued in the chapter—and I made that point before—there is some de-linking between inflation and domestic economic conditions, the link is not totally obsolete despite globalization. So to the extent that strong domestic economic activity continues, you would also still see some upside risk from that side.

Question: And, finally, what does all this imply for policymakers? For example, policymakers such as central bankers, have they been squeezed out of the picture?

Thomas Helbling: No, not at all. As I tried to emphasize on several occasions during the interview, that what matters most for average inflation or nflation in the immediate term is really your nominal anchor, which is given by monetary policy. What I mean by nominal anchor, is the monetary policy target. In industrial countries today, this is some sort—whether it's implicit or explicit—of an inflation target, and that really anchors inflation over the average, and that plays and continues to play a key role. And globalization cannot be a substitute for that. Another reason why monetary policy still matters is the way monetary policy is conducted over the cycle. To the extent that monetary policy has been successful in anchoring inflation not only in the long run, but also over the cycle, is people expect inflation to stay relatively closely to the inflation target, this also means that shocks or disturbances, including those of—related to globalization, say, for example, a large change in import prices will have a relatively short-lived effect. So from both angles, both the average inflation rate and the behavior of inflation over the cycle—for both of these phenomena—monetary policy continues to play a key role.

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Awash with Cash: Why Are Corporate Savings So High?
World Economic Outlook, April 2006, Chapter IV
Prepared by Roberto Cardarelli and Kenichi Ueda
Senior Economist, Research Department and Economist, respectively, Research DepartmentVideo Presentation

Question: Why are corporations stockpiling assets rather than reinvesting in their businesses or paying dividends.

Roberto Cardarelli: Let me tell you first that this is a real unprecedented phenomenon. Normally, corporates borrow resources from the other sectors of the economy, like the household sector and the government sector. What's happening particularly in the G-7 countries, has been that corporates have actually been lending resources to the other sectors of the economy. So that's pretty much unprecedented over the last 30 years. Why is that? One frequently cited reason is that firms have been accumulating too much debt and too much fiscal capital at the end of the '90s. And when the stock market crashed in 2000, they ended up with a high level of debt, and they've been basically trying to restructure the balance sheet after that. So it is a reaction to that episode—the reason why they've been cutting capital spending and saving. The chapter says actually something slightly different. There are basically three reasons why we believe corporates have been saving so much over the last few years. One is that profits have been very high because of lower interest expenses and lower corporate taxation. The second reason is that firms in the G-7 have been replacing domestic investment with purchasing equities abroad, I mean, fiscal capital abroad. And the third reason is that firms have been accumulating more cash, more liquidity, actually, than used to be the case.

Question: And why is it that firms are accumulating so much liquidity?

Roberto Cardarelli: The chapter argues that there are basically three factors that are driving this. One is that firms, corporates, in industrial countries are living in a more uncertain environment, probably because of globalization and increased competition in thegoods market because of globalization. So they have been saving more in order to cope with this increased volatility. Another reason is that the weight of intangible assets, like, for example, [unintelligible] and good will, has increased. There are more and more knowledge-based companies, and these companies tend to save more to invest in these intangible assets, which are more difficult to give as a collateral to the lender. So for them, it's easy actually to invest using internal savings, internal funding, rather than external financing. Another reason is that firms have been accumulating unfunded pension liabilities in industrial countries, and they may have been holding more cash because of the uncertainty related to when and how much they're going to be forced to meet these unfunded liabilities. So it's a reaction to the external uncertainty coming from the unfunded pension liabilities.

Question: Is this trend likely to continue?

Roberto Cardarelli: The chapter argues that, because of these reasons, we see corporates' financial position are not returning to the big borrowing position of the past, but at the same time, we don't believe that corporates will keep saving to the extent they've been doing over the last two, three, four years, especially if investments are going to pick up, and some of the factors that have been driving profits are going to wane, for example, interest rates are gradually coming to more normal higher levels, and that's going to take some steam off the higher profits of corporates.

Question: What impact will this phenomenon have on the global economy?

Roberto Cardarelli: We believe that a reduction in corporate savings is going to put upward pressures on interest rates, especially if you consider that over the last two years corporate savings has been instrumental in keeping low global interest rates. One commonly cited reason why this is the case has been the higher rate of accumulated current account surpluses of emerging markets in oil-producing countries, the "global savings glut," to use the words of the current Chairman of the Federal Reserve. But over the last two years, excess savings by corporates has actually been twice as much as the accumulated current account surpluses of emerging markets. So we really believe that if corporate savings is going to decrease over time, that it is going to actually produce some pressure on interest rates going forward.